In Chief Counsel Advice (CCA) 201624021, the IRS affirmed that taxable asset acquisitions are "covered" transactions for acquirers but not for targets, and, therefore, targets are ineligible to deduct success-based transaction costs using the elective safe-harbor method because the election is available only for covered transactions. Although it may not be used or cited as precedent, the CCA provides helpful insight to taxpayers planning or negotiating merger and acquisition transactions.
Facts of the CCA
On Dec. 31, 2012, the shareholders of an S corporation sold all of their outstanding stock to a corporation. The parties jointly elected to treat the stock acquisition as a taxable asset acquisition under Sec. 338(h)(10). In connection with implementing the transaction, the target S corporation incurred transaction costs consisting of success-based fees paid to an investment bank and non-success-based expenses to draft information memoranda, review contracts, and prepare letters of intent. With respect to the success-based costs, the target S corporation attached a statement to its timely filed original 2012 federal income tax return electing to deduct 70% of these costs and to capitalize the remaining 30%, under the safe-harbor allocation method described in Rev. Proc. 2011-29.
Transaction Costs Generally Capitalized
Regs. Sec. 1.263(a)-5 largely governs the federal income tax treatment of transaction costs incurred in connection with 10 types of transactions listed in Regs. Secs. 1.263(a)-5(a)(1) through (10), with the first being "[a]n acquisition of assets that constitute a trade or business (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition)."
Regs. Sec. 1.263(a)-5(a) provides that transaction costs paid to "facilitate" any of the enumerated transactions must generally be capitalized, regardless of "whether the transaction is comprised of a single step or a series of steps carried out as part of a single plan and without regard to whether gain or loss is recognized in the transaction."
Exception: Covered Transactions Safe Harbor
However, Regs. Sec. 1.263(a)-5 also provides several exceptions and special rules that permit taxpayers an accelerated deduction for expenses of certain covered transactions, including the "bright-line" date exception in Regs. Sec. 1.263(a)-5(e), under which transaction costs are not required to be capitalized to the extent they are incurred to investigate or otherwise...